September 13, 2012 / 12:06 AM / 5 years ago

Investors see obstacles, risks to BAE-EADS tie-up

Workmen stand in the BAE Systems' Govan shipyard in Glasgow, Scotland May 26, 2011. REUTERS/David Moir

PARIS/BERLIN (Reuters) - Shares in EADS EAD.PA and Britain’s BAE Systems (BAES.L) tumbled on Thursday as investors feared a planned tie-up aimed at creating the world’s biggest defense and aerospace group could run up against political obstacles.

If talks unveiled late on Wednesday culminate in a deal, BAE shareholders would hold 40 percent and EADS investors 60 percent in a giant with products ranging from Airbus commercial planes to Typhoon warplanes and BAE’s Astute-class nuclear-powered submarines.

Potentially the biggest shake-up in the European aerospace and defense sector in a decade, it would underline the push by defense firms to offset the impact of shrinking national military budgets with more revenues from the commercial sector.

But the accord will need the political backing of Germany and France to unravel the 12-year-old shareholder pact underpinning the strategic European aerospace champion, while the enlarged group must win the trust needed to deal with security-minded customers from the Pentagon to the Gulf.

Pressed for comment, Chancellor Angela Merkel told reporters only that the deal was being checked by Berlin. With European politicians wary of the impact on jobs - especially in France where unemployment has hit 13-year highs - the head of EADS’ Airbus unit sought to reassure staff on the deal.

“Such a combination would strengthen EADS and BAE Systems - thereby making Airbus part of a stronger company overall,” Fabrice Bregier said in a letter to employees, adding that any deal would not affect Airbus’ organization, product plans, manufacturing or future strategies.

Yet by 1520 GMT, EADS’ shares had fallen more than 10 percent to 25.10 euros and BAE shares were down seven percent to 337.5 pence as investors acknowledged the logic of the move but fretted that shareholders would lose out.

“A merger would allow EADS to achieve its aim of balancing civil aerospace ... with non-Airbus activities,” Citigroup analysts said in a note.

“However, we believe that achieving merger synergies for the combined entity could be difficult, particularly given the need to ring-fence certain strategically sensitive activities,” they added, downgrading EADS’ shares to “neutral” from “buy”.

Ratings agency Fitch said the tie-up had “sound industrial logic” but added: “Considering the complexity and security sensitivity of some defense contracts, this may prove to be a long and arduous process.”

GROWTH RETHINK

Western defense spending is under severe pressure from public finances on both sides of the Atlantic, forcing Europe’s two largest defense companies to rethink strategies for growth.

“I think it is now recognized that you can’t sustain a global defense company off the budget of a medium-sized or even large-sized European country,” said Nick Witney, senior research at the European Council on Foreign Relations.

BAE will regain a foothold in the commercial aircraft business through Airbus, undoing its decision to exit in 2006 and giving up a pure-play defense strategy.

EADS will absorb the consequences of failing to win a huge contract to sell tankers to the U.S. Air Force last year and give up trying to conquer the world’s largest arms market alone.

Yet one investor who bought into EADS in 2009 at less than half its price before the talks announcement fretted that the deal would dilute EADS’ existing attractions and so ultimately turn sour for both sets of shareholders.

“This is a deal without logic and without winners. The whole of the proposed combination is inferior to the sum of the parts,” said Barry Norris of UK-based Argonaut Capital Partners, holder of 500,000 EADS shares.

The combined group as it stands would eclipse U.S. rival Boeing (BA.N) with sales of about 72 billion euros ($93 billion), based on 2011 numbers. It would total some 220,000 employees worldwide.

The deal would unpick the ownership pact agreed for EADS since its creation in a 2000 merger. French media-to-aerospace group Lagardere (LAGA.PA) owns 7.5 percent of EADS, with the French state holding 15 percent. German car maker Daimler (DAIGn.DE) holds 15 percent, with 22.5 percent voting rights.

The current status quo could be replaced by special shares for all three governments that would give them the power to veto any hostile takeover bid.

DAIMLER EXIT?

A Daimler spokesman said on Thursday that a merger could allow it to exit its stakeholding. Germany had already agreed, via state-owned bank KfW, to buy half of Daimler’s stake to ensure the Franco-German balance.

“Since the planned transaction would also be linked to a possible dissolution of the shareholder pact, all options would be open to us in principle - including the possibility of selling our stake on the open market,” he said by email.

The political implications are equally complex.

Rather than making BAE more European, the deal appears designed to make EADS more American - potentially to the chagrin of the French government and other French aerospace companies.

Until now, EADS has sat uncomfortably at the middle of a triangle of misaligned political and economic relationships.

While France and Germany underpin both the euro and EADS politically, France and Britain are Europe’s biggest military powers and Germany and Britain dominate its defense industry. None of these pairings alone has generated adequate business.

German sources told Reuters the German government had yet to approve the merger, while France said it would wait before commenting. Yet one industry source said there were encouraging signs from both countries involved that a merger could go ahead.

French Industry Minister Arnaud Montebourg told France Inter radio he could not comment on the deal because of “reasons of confidentiality”, but added that “this is a very important strategic, geo-strategic negotiation”.

($1 = 0.7759 euro)

Additional reporting by Lionel Laurent in Paris, Christiaan Hetzner in Frankfurt; Victoria Bryan and Andreas Rinke in Berlin, Sophie Sassard in London and Tim Hepher in Alabama; Andrea Shalal-Esa in Washington; Writing by James Regan and Mark John, editing by Peter Millership

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